Just lately, I supplied some ideas on the VanEck Mortgage REIT Revenue ETF (MORT). I used to be cautious on MORT and mortgage REITs (“mREITs”) generally, as I used to be frightened a couple of doable firesale of mortgage-backed securities (“MBS”) and the Fed’s continued quantitative tightening program.
This text seems to be on the iShares Mortgage Actual Property ETF (BATS:REM), an ETF that invests in the identical securities because the MORT ETF, and the implications from continued deposit flight from regional banks.
I imagine regional financial institution deposits are structurally unattractive in comparison with cash heart banks with implicit authorities ensures or cash market funds with far increased yields. The answer to deposit flight will doubtless inevitably result in increased funding prices for regional lenders, which can result in tighter lending requirements and a doable ‘deep freeze’ in actual property finance.
Transient Fund Overview
The iShares Mortgage Actual Property ETF offers publicity to mortgage REITs that maintain U.S. residential and industrial mortgages. The REM ETF tracks the FTSE Nareit All Mortgage Capped Index (“Index”), an index which measures the efficiency of the residential and industrial mortgage actual property and associated sectors of the U.S. fairness market.
The REM ETF has $562 million in property and prices a 0.48% internet expense ratio.
Much like the MORT ETF, REM’s portfolio is generally comprised of mortgage REITs like Annaly Capital Administration Inc. (NLY) and AGNC Funding REIT Corp. (AGNC).
In contrast to conventional REITs, mREITs don’t personal or function actual property properties. As a substitute, they’re actual property funding trusts that present financing for actual property by shopping for or originating mortgages and mortgage-backed securities (“MBS”). MREITs usually function by originating mortgages after which hedging out rate of interest publicity, so buyers get levered publicity to mortgage spreads. mREITs require properly functioning actual property finance markets with banks offering loans and liquidity.
Determine 1 exhibits the complete holdings of the REM ETF.
The REM ETF and MORT ETF share many overlapping holdings. Actually, the historic efficiency of the REM and MORT ETFs are just about equivalent, measured from September 2011 (MORT’s inception date) to February 2023 (Determine 2).
How Deposit Flight Might Lead To Credit score Tightening
Returning to the primary subject of this text, I imagine the current regional financial institution failures and deposit flight could result in a deep freeze in actual property markets.
First, a recap of what has occurred thus far. On March ninth 2023, SVB Monetary Group (SIVB) shocked markets by asserting an fairness elevate to plug a capital gap from promoting a portfolio of available-for-sale (“AFS”) company MBS securities at a deep loss.
Traders had been blindsided by the capital elevate and scale of the capital deficits at SIVB, and by the weekend, SIVB and Signature Financial institution (SBNY) had suffered basic financial institution runs and had been positioned into FDIC receivership. FDIC and the federal government vowed to guard all depositors, even those who had greater than $250,000 in insured deposits.
Sadly, the 2 regional financial institution failures shone a lightweight on the dimensions of the unrealized losses sitting on financial institution stability sheets and really exacerbated the run in public confidence (Determine 3).
Moreover, the federal government’s actions have now created a 3-tiered banking system. First, there are SIVB and SBNY depositors, which now take pleasure in ‘specific’ ensures from the FDIC. Then there are the cash heart banks (JPM, BAC, C, WFC) which can be ‘too massive to fail’ and have ‘implicit’ ensures of help from the federal government. Financially, there may be everyone else.
Confronted with the prospect, nevertheless distant, of potential losses on one’s deposits, depositors did the rational factor and transferred their deposits out of regional banks and into both one of many massive cash heart banks or into cash market funds.
Keep in mind, with the typical deposit account paying solely 37 bps in curiosity, there was additionally an financial incentive to maneuver one’s cash out of regional financial institution deposits into cash market accounts incomes 4 to five% (Determine 4).
So within the week ended March fifteenth (the week after SIVB failed), financial institution deposits fell by $98 billion total. Nonetheless, deposits at small lenders slumped by $120 billion whereas these on the 25 largest monetary establishments rose by $67 billion, highlighting the flight to ‘too massive to fail’ banks.
In the identical time interval, cash market funds noticed $121 billion in inflows, largely in institutional cash market accounts (Determine 5).
Moreover, within the week ended March twenty second, cash market funds noticed one other $117 billion in inflows, suggesting that deposit flight out of regional banks has not slowed down, regardless of repeated assurance of help from authorities officers like Treasury Secretary Yellen.
Whereas regional banks can supply liquidity to fund deposit outflows from the Federal Reserve by lending amenities just like the low cost window or the newly created Financial institution Time period Funding Program (“BTFP”), there are financial prices to those amenities in comparison with ‘extremely low cost’ deposits. For instance, BTFP loans should pay in a single day index swap charges (at present 4.73%) plus 10 bps. Alternatively, regional banks can attempt to stem the outflow of deposits by elevating deposit charges to engaging ranges in comparison with cash market funds to retain clients. Nonetheless, each choices would result in decrease profitability for banks.
When confronted with decrease profitability, regional banks are anticipated to tighten lending requirements and credit score situations, because the marginal mortgage will now not be worthwhile with increased funding prices.
This residue flight / credit score tightening course of is what Chairman Powell was referring to, when he mentioned in his post-FOMC press convention that “occasions within the banking system over the previous two weeks are more likely to end in tighter credit score situations for households and companies”.
Regional Banks Are Massive Actual Property Lenders
The problem for the actual property finance market is that small regional banks are literally very massive gamers in actual property markets. For instance, within the newest FDIC Quarterly Evaluate, we will see small and medium sized lenders (these with lower than $250 billion in property), collectively maintain $3.9 trillion in actual property loans (68% of complete actual property loans held by FDIC-regulated banks) (Determine 6).
Even earlier than the newest regional financial institution failures, banks had been already tightening lending requirements (Determine 7).
If funding prices for regional lenders go up, we must always count on even additional tightening from the banks. This might result in a deep freeze for actual property finance markets.
It’s no marvel that enormous actual property buyers like Barry Sternlicht of Starwood Capital have been warning of a critical ‘arduous touchdown’ on nationwide TV.
The iShares Mortgage Actual Property ETF offers publicity to mortgage REITs that maintain U.S. residential and industrial mortgages. Along with short-term dangers from a hearth sale of seized financial institution property and long-term danger from the Fed’s quantitative tightening, I imagine there’s a very actual danger of a deep freeze in actual property markets as regional banks are pressured to drag again on actual property lending as a result of growing deposit flight disaster.
Regional financial institution deposits are structurally unattractive in comparison with cash heart banks with implicit authorities ensures or cash market funds with far increased rates of interest. Any answer to deposit flight will cut back financial institution profitability which can trigger them to tighten lending requirements.
I’m hesitant to put money into mREITs and ETFs like REM and MORT till this banking disaster is resolved.